Can your business spend less on sales tax compliance

Every day, sales tax compliance gives someone somewhere a headache. Sometimes it’s mild and clears quickly after a bit of research. Sometimes it lasts for days. And sometimes it lingers around the edges like a migraine coming on: You sense it, dread it, and do everything you can to stave it off.

The headache can be caused by the simplest things, a question in need of an answer, a form in need of filing. A mom-and-pop market in Vermont decides to stock a new type of beverage and needs to know whether the drink is subject to Vermont’s sales and use tax. Some beverages are sales tax exempt in Vermont, but as of July 1, 2015, “beverages that contain natural or artificial sweeteners” are taxed. Will determining the taxability of their new product be as easy as scanning its ingredients? Perhaps, perhaps not. More likely, the retailers will have to spend some time browsing the Vermont Department of Taxes website.

Still, that’s a mild headache in the world of sales tax. No ibuprofen needed. It’s the envy of a business like The Vitamin Shoppe, which offers more than 25,000 SKUs in more than 700 stores across the United States. State taxability rules regarding dietary and digestive products vary widely from state to state, and like the Vermont soda tax, often hinge on ingredients. According to sales tax manager Diana Rancy, “It has taken me three days to research and categorize just 100 items. Can you imagine how long it would take me to do more than 20,000?”

Patrick Gillespie had an inkling when employed by the Washington State Department of Revenue back in 2010. He built a database of every kind of candy sold in the state and was at 6,000 and counting when interviewed by National Public Radio that May. Although exempt from Washington sales tax today, candy was taxable June 1, 2010, through December 1, 2010 — unless it contained flour. Thus, the database: Gillespie had to read the ingredients of every kind of candy sold in the state to determine whether it was taxable or exempt.

Needless to say, it takes time and resources to get sales and use tax right. Exactly how much time and how many heads depends on the size and industry of your company. The methods used to manage sales tax also play a key role.

Always interested in this topic, Avalara asked NetReflector/Potentiate to find out the true cost of sales tax compliance for companies of differing sizes across several industries. Potentiate surveyed hundreds of companies in the United States to suss out the methods, staffing requirements, and expenses associated with managing sales and use tax compliance manually (i.e., without an automated sales tax solution).

The survey gathered information about each company’s sales. It identified the scope of a company’s sales tax compliance activity, such as the number of returns filed and filing frequency. And it asked how many people and hours each participant devoted to sales tax, along with hourly wages or rates. Finally, Potentiate inquired about audits.

Key findings are described below. What stands out is that a company’s size and industry tend to dictate how many resources it devotes to sales and use tax compliance. Furthermore, although survey respondents are generally confident they’re compliant, evidence suggests some may not be. 

Each aspect of sales tax compliance requires more time of SMBs than it does for ESBs. Every month, SMBs devote 3 additional hours to identifying sales tax obligations and filing requirements, 5.7 more hours to tax rates and calculations, 6.6 more hours to exemption certificate management, 7.8 more hours to consumer use tax, and a whopping 8.7 additional hours on tax returns.

In addition to putting more employees toward sales tax, SMBs tend to have hired more staff to help with tax compliance when compared to their smaller counterparts. They’re also more likely to employ external service providers.

Considering hours spent and cost per hour, SMBs allot 40% more to service providers than ESBs allocate each month: $2,455 versus $1,748. This is on top of money spent on internal staff.

Software companies also spend less ($1,492) on external service providers than companies in other industries spend. Manufacturers tend to bring in the most external help: They generally spend $3,638 each month on service providers, while retailers spend $2,093.

The survey couldn’t — and didn’t intend to — discover whether respondents were compliant or noncompliant. Yet it’s safe to assume at least some of the companies surveyed should be registered for sales tax in at least one state where they currently aren’t.

An audit would uncover noncompliant activity, and participants were asked about their audit experiences.

Manufacturers audited more than retailers and software companies

Manufacturers were more likely to be audited than retailers and software companies: 18% of manufacturers versus 10% of retailers and 4% of software companies. Manufacturers were also more likely to owe penalties after the audit, though their penalties tended to be lower than those of retailers and software companies.

The survey cautions that many of the audit-related findings, particularly for ESBs, come from “extremely small base sizes.”

All aspects of sales tax can lead to penalties

What triggered the audit penalties? Reasons include everything from late filings to consumer use tax liabilities and failure to register in a state when required. Yet sales tax rate or rule errors and missing exemption certificates were the top two reasons.

It’s worth noting that only 21% of the businesses surveyed said they kept money aside to respond to audits. Among those that did, the amount of the reserve budget varied considerably by size. The mean reserve budget for ESBs was $9,790; the mean reserve budget for SMBs was $457,638.

Again, the survey cautions that the reasons for audit penalties came from “extremely small base sizes.”

This is in line with findings from a recent survey of accounting professionals. More than 52% of the accountants surveyed said that because of the pandemic, “keeping up with changes in online technologies” was highly important for small businesses. And 54% of them indicated their own companies could benefit from more cloud-based software, too. According to the accountants, “more automation, less handwork” is key “to remain competitive.”

Like a lot of us, many accounting professionals were forced to work remotely during the early months of the pandemic. And like a lot of us, many still are. Cloud-based technology allows information to be shared securely with colleagues and clients in disparate locations.

New technology costs, to be sure, but as the Potentiate survey reveals, many hands make manual compliance costly, too. Companies are paying for employees to manage sales tax and they’re paying for external service providers to manage sales tax. Some also pay audit penalties when employees and external service providers make mistakes, which they’re bound to do because sales tax compliance entails navigating a confusing labyrinth of sales tax rates, rules, and requirements in up to 45 states, plus Washington, D.C., and parts of Alaska.

Find out how much time you can save by automating sales tax compliance.

Sales tax rates, rules, and regulations change frequently. Although we hope you'll find this information helpful, this blog is for informational purposes only and does not provide legal or tax advice.